7   Dances with Wolves

In March 1999, the accounting firm BDO Seidman was struggling. Founded as Seidman and Seidman in New York in 1910, the firm expanded a few years later to Grand Rapids, Michigan, to serve the furniture industry, for which it developed the first furniture plan costing system. The firm developed a strong presence in the Midwest and opened additional offices on the East Coast. Former managing partner L. William Seidman had served as chair of the Federal Deposit Insurance Corporation from 1985 to 1991 and had played a lead role in liquidating hundreds of failed savings and loan associations that had gone into federal receivership during the collapse of the industry in the 1980s. BDO, which moved its headquarters from New York to Chicago in 1997, occupied the second tier of accounting firms below the Big Five. The firm didn’t have the extensive sales network of global or even national offices that the Big Five had. Instead, it relied on programs like its Alliance Distribution Channel, which involved relationships with smaller accounting firms across the country. BDO provided these firms with tax expertise in return for a fee and access to their customer bases.

On March 17, 1999, the BDO board passed a resolution declaring “serious negative variances” in “operations and trends at the end of January 1999.”¹ In other words, the firm’s financial situation was dire. Especially troubling was the prospect that the firm would be in violation of its debt covenants establishing the minimum amount of cash that it had to have on hand.² According to the board, its financial oversight committee and national tax director Denis Field would work with BDO’s executive committee to “analyze financial statements and [would] take actions at the appropriate offices.”³ Ultimately, several partners were terminated. Chief executive and board chair Dan Pavelich resigned and was succeeded by Richard Roedel. In attempting to address the firm’s financial troubles, Roedel relied on an inner circle of partners. Among them was Denis Field, who had led the firm’s charge into the shelter market.

“Tax $ell$!”

Field’s star was on the rise at BDO. He had come to the firm after earning a master’s degree in tax law at New York University. Highly regarded for his technical expertise, he worked in international tax before becoming the national tax leader of the firm in 1996. In that position he had begun to boost BDO’s revenues from various products designed to minimize clients’ taxes. He called together key tax partners in New York in May 1996 to brainstorm about how to make tax practice more profitable. Like tax leaders at other accounting firms, Field wanted to move away from a focus on tax returns toward an emphasis on “value-added” consulting services. BDO had first done such a transaction when it approached an investment bank about handling a tax transaction for a BDO client. The bank had charged the client based on a percentage of the tax savings from the transaction and then paid BDO a fee from that.⁴ Terry Kelly, a partner in the Grand Rapid office, suggested at the May 1996 meeting that the group call itself the “Wolf Pack,” and soon Wolf Pack teams were visiting local BDO offices to help strategize about how to become more profitable.⁵

Field also encouraged firm members to develop and capitalize on networks such as the Alliance Distribution Channel to market the firm’s products. He created a fund to pay bonuses to partners and employees who sold value-added transactions, some of which were tax shelters. Field had unilateral authority to determine who would receive bonuses from this fund before any other distributions were made to partners.

In 1998 an informal BDO tax products leader group was formed consisting of Field, Charles Bee, Adrian Dicker, Michael Kerekes, and Lorin Luchs. Members informed the national sales executive group which tax products were available, and the latter group worked to find clients who would be interested in these products. BDO also sought out tax shelter providers and put them in touch with BDO clients. Clients who bought the shelters would pay the providers a fee, who in turn paid BDO for the referrals. The firm formed a tax opinion committee as part of the tax leader group. This group was charged with reviewing potential products and determining which ones the firm would market. The committee also determined which products would generate bonuses for those who sold them and assumed responsibility for allocating these bonuses among sales force members.

In June 1999—in the midst of the firm’s financial crisis—Adrian Dicker, after extensive discussion with Field and other key partners, sent a memo to Richard Roedel suggesting the establishment of the tax product program as a separate business line. The new business would be formed as a limited liability company (LLC), which meant that BDO would not be responsible for its liabilities. Dicker proposed that he, Field, and Bee would receive compensation based on the profitability of this business. This represented a shift from the traditional compensation system in accounting firms, which allocated units to partners that represented entitlement to a portion of the overall earnings of the firm. Roedel approved Dicker’s proposal, and in October 1999 the tax leader group and the national sales executive group were merged into what was called the Tax Solutions Group. Field, Bee, and Dicker would each receive 10 percent of the net profits generated by its activities.

In early fall, Field announced the formation of the group to BDO partners. As he explained, the group’s sales model provided that any BDO partner who had a client expecting a large gain from the sale of stock, a company, or other assets would notify a member of the Tax Solutions Group, who would then pitch the shelter to the client. The referring partner would receive a bonus for his or her referral. Field informed firm partners that members of the group would be in close communication with them in whatever way was most effective. “This may be via conference calls or meetings,” his memo noted, but “is unlikely to be via pieces of paper setting out the transactions.”⁶ As at other firms, the absence of a paper record minimized the likelihood of competitors’ learning the details of BDO’s shelters and was a precaution to prevent information from getting into the hands of the IRS.

In the new group, Dicker focused on administrative matters such as accounting of money for bonuses, Bee on technical tax issues, and Field on motivating partners to find clients to do transactions. The tax opinion committee, which reviewed and approved tax products, was comprised of Field, Bee, Dicker, and Robert Greisman, who had been recruited a year earlier to BDO by Field’s assurance that tax partners at the firm would routinely make $1 million a year. For the committee to approve a transaction, a unanimous decision was required.⁷ Michael Kerekes, a partner in Los Angeles, was responsible for reading new cases and notices and apprising everyone of their implications.⁸ Tax Solutions Group members, who numbered around twenty, covered different parts of the country. The general tax partner referring a client to the group would tell the client that BDO had a Tax Solutions Group that had ideas to reduce or eliminate taxes. The partner would outline to the appropriate group member the client’s gain, how it arose, and when it was expected. The group member then scheduled a phone call or a meeting to discuss the shelter with the client.⁹

Field was a tireless cheerleader for tax shelters within the firm, with an aggressive style that “pushed people.”¹⁰ The slogan “Tax $ell$” was plastered on coffee mugs, documents, screen savers, and mouse pads throughout the firm. More than a slogan, Field declared, “Tax $ell$” was a “vision for the future,” a strategy for “selling products, increasing fees, and increasing profitability.” Finally, Field said, and “[m]ost importantly,‘Tax $ell$’ is a change in the culture of all our people and our attitude to tax services.”¹¹ Field seized on the idea that the group was a wolf pack. He was without question “the alpha wolf,”¹² and led Wolf Pack members in howling like wolves at sales meetings.¹³

Field did a presentation to tax partners in the fall of 1999 that exemplified his approach to selling tax products. His presentation, which discussed the tax services business line, was entitled: “Wolves—Always Friendly But Never Tame.”¹⁴ One slide proclaimed:

We can turn the grayest sky to green

June 30, 1998 $2.2 Million Actual Profit.

We can make it rain whenever we want it to!

June 30, 1999 $14.8 Million Actual Profit.

We can turn a raging fire into a green river.

June 30, 2000 $75+ Million Profit Goal

With all the power we possess we can change BDO into a green ocean.¹⁵

A few slides later came the proclamation: “One word sums up the strategy of the Tax Business Line. MONEY! All of us in the Firm need to focus on money. Think Green. Green is good! There’s nothing wrong with trying to make more money.”¹⁶ In case anyone wondered, “Where is the real money? SHOW ME THE MONEY,” the answer was: “It’s right in front of our faces. Our clients have the money. And we have the services they’ll pay for.”¹⁷ Those services included tax consulting, financial planning and financial services, and “the super product category: Tax Solutions.”¹⁸ Field underscored the bonuses paid to the Tax Solutions Group the previous year, which totaled $4.6 million. In 2000, the goal was to pay $7.3 million. “You can all get in on this sea of green at BDO,” Field’s presentation concluded. “With the power, talent, and knowledge we possess in our Wolf Pack, we can turn BDO into a green, green ocean.”¹⁹

With the Tax Solutions Group booming, Field ran a successful campaign in late 1999 to be named to the BDO board by its nominating committee. Bee also became a board member then, giving tax solutions even more clout. Field continued his meteoric rise when not long afterward a majority of the board decided to name him to replace Roedel as CEO and chair of the firm. Field assumed office at the beginning of 2000. At forty-one, he was the youngest partner ever to hold these positions. He would also continue as a member of the Tax Solutions Group. After taking over as CEO, he named each Tax Solutions Group leader a vice chairman to distinguish them from other partners. This resulted in a substantial increase in compensation for all members of the group. For Bee and Adrian Dicker, who joined the board shortly afterward, compensation jumped from $250,000 to $750,000 a year. “Tax $ells!” had effectively been Field’s campaign platform, and the alpha wolf was now clearly in charge.

The Daugerdas Connection

A year earlier, Robert Greisman had had a meeting that would catapult him to a rarefied level in the BDO pecking order. A corporate lawyer at the Chicago law firm of Altheimer & Gray, whom Greisman knew from his prior work at Grant Thornton, introduced him to Paul Daugerdas. Greisman and Daugerdas met for dinner at Trattoria No. 10 in Chicago. The two discussed Daugerdas’s work with an accounting firm that referred clients to him for transactions that would reduce or eliminate their tax liability. Daugerdas went on to describe a transaction called Basis Enhanced Security Transaction (BEST), which involved selling a two-year Treasury note short, purchasing another note, contributing both to a partnership, and taking advantage of partnership tax rules to increase the taxpayer’s basis. When the partnership was liquidated through the transfer of its assets to a subchapter S corporation, taxpayers used the increased basis to claim a loss sufficient to offset whatever income they wanted to shelter.

As Daugerdas explained, he created the partnership and the S corporation, arranged with Deutsche Bank to execute the purchase and sale of options, and provided a legal opinion that stated that the tax treatment more likely than not would be upheld if challenged by the IRS.²⁰ He charged a fee equal to 3 percent of the capital gains tax savings and 4 percent or more for tax savings on ordinary income, which was taxed at a higher rate. Daugerdas offered to share a portion of his fee in return for BDO’s referral of clients to him.

Greisman reported back to Field about his dinner with Daugerdas. His interest piqued, Field asked Greisman to set up a conference call to follow up. Greisman did so after signing a confidentiality agreement on behalf of BDO that had been prepared by Daugerdas. Although no one in the group had worked with Daugerdas, Bee had overlapped briefly with him at Arthur Andersen. According to Bee, Daugerdas had a reputation as a tax whiz. Field, Dicker, Bee, Kerekes, and a few other BDO partners participated in the call, quizzing Daugerdas about various aspects of the shelter he was selling.

The tax opinion committee then considered the proposed arrangement. Despite the appetite at BDO for value-added transactions, there was some concern about a fee structured as a percentage of what could be huge tax savings. Greisman mentioned that he had never seen a fee for a tax opinion letter that was based on a percentage of the tax savings. The fear was that the IRS might recharacterize the fee as a transaction cost that offset any potential for profit from the trading. This would eliminate any economic substance to the transaction—since it eliminated the reasonable possibility of making a profit—and make reliance on the tax opinion unreasonable. Another firm, for instance, charged a flat $100,000 fee and did no other legal work on the transaction. As an internal BDO memo suggested, “The fee paid for [this] tax opinion is not a cost of the transaction, and at the level of $100,000, where the law firm provides no additional services, is presumed to not be in danger of a recharacterization as a transaction cost.”²¹ By contrast, Jenkens & Gilchrist performed work forming and dissolving various entities and managing the short-sale process. Daugerdas nonetheless took the position that his fee was for a tax opinion and should not be considered a cost of the transaction because the economic analysis of that transaction did not include consideration of its tax impact.

During the committee’s discussion, Bee questioned whether there was any meaningful potential to profit from a short sale of such brief duration. He was worried that Daugerdas’s role in designing and promoting the shelter eliminated the possibility of treating his legal opinion as independent. He and Dicker also apparently believed that one or more IRS Revenue Rulings had indicated that tax losses from a transaction like the short sale would not be recognized by the agency.²² The opinion committee discussed these and other concerns in deciding whether to establish a referral relationship with Daugerdas. Field eventually persuaded the committee to approve the arrangement, arguing that even if the IRS disallowed the tax treatment for the transactions and assessed interest and penalties on the taxpayer, the worst that would happen to BDO would be that it would be sued by a client for the fees that the client had paid. In November 1998, BDO began to market the Treasury short sale with Daugerdas.

Under the arrangement, BDO made the sales pitch to clients and secured the business before introducing them to Altheimer & Gray and, when Daugerdas and his colleagues moved firms, to Jenkens & Gilchrist. The lawyers took care of the logistics, provided a legal opinion, and arranged for David Parse of the investment bank Alex. Brown & Sons to execute the trades. Very few clients actually met with Daugerdas, but one who did asked why everyone wasn’t using the shelter if it worked so well. “Everybody doesn’t know me,” Daugerdas replied.²³ Greisman originally worked with Daugerdas on the transactions, but eventually came to work more with Donna Guerin as his main contact at the firm. The parties agreed that BDO would get 20 percent of the fee that the law firm received.

BDO’s arrangement with Daugerdas proved profitable from the beginning. A January 12, 1999, letter from Greisman to Daugerdas listed fees due to BDO. BDO’s involvement in the shelter had begun only in November of 1998; by January, the total came to almost $2.2 million.²⁴ A large portion of the fees was generated by Paul Shambron of BDO’s Detroit office. Denis Field had asked Greisman to keep him closely apprised of the fees BDO was earning from the relationship with Daugerdas because the report was that this arrangement was going to be a big moneymaker.

In October 1999 Greisman learned from Daugerdas, who by then had moved to Jenkens & Gilchrist, that Jenkens would be changing the shelter transaction to substitute trading in currency options for Treasury bill short sales. The new arrangement provided some flexibility to fine-tune losses. If clients wanted a capital loss, they would trade stocks or bonds; if the desire was for a loss to offset ordinary income, the trading would be in foreign currencies.²⁵ The product essentially would be the same, but Daugerdas was concerned that legislation might be passed that would explicitly close the loophole in the treatment of Treasury short sales under partnership provisions of the tax code.²⁶ Trader David Parse at Deutsche Bank would continue to arrange for the trades to effectuate the shelter transactions.

The BDO tax opinion committee reviewed the revised shelter to decide if the firm should participate. BDO was familiar with a short option strategy involving options on foreign currency because it had been recommending such shelters to clients. There were still, however, some concerns about the new Daugerdas transaction. Bee feared that there was little meaningful profit potential when the two trades were analyzed together and suggested to Daugerdas that a 4 percent fee was quite large in comparison to this potential. Daugerdas continued to insist that his fee would not be counted as a transaction cost related to the investment and claimed that if an IRS investigation occurred, description of that fee on the bill would be protected from disclosure by the attorney-client privilege.²⁷ By the end of the meeting, Bee’s misgivings were outweighed by the substantial fees that BDO would earn on the shelters. He gave the transaction a green light.²⁸ Eventually, BDO informed Jenkens that it was arranging for the client to add some additional cash to the partnership and to engage in some additional trading to make it appear that there was more profit potential. The detailed instruction sheet Greisman prepared for the Tax Solutions Group members to use in executing the transactions, however, made clear that every step was scripted and that concerns about investment returns were irrelevant.²⁹ BDO personnel referred to the change in the transaction that ostensibly provided a reasonable opportunity for a meaningful profit as the “lottery” feature.³⁰

The Tax Products Group took pains to create a record to support a claim that the transaction had economic substance in case the taxpayer was audited by the IRS. Kerekes in particular was sensitive to the need for an appropriate paper trail. In an email to other group members, he noted with alarm that Jenkens had sent clients certain forms with simply a blank for the dollar amount. “The clients had no clue what to fill in,” Kerekes said. “Are the clients supposed to sign and send back blank forms? Talk about a bad fact for business purposes.”³¹

In late 1999, Tax Solutions Group members discussed the need to put material into clients’ files that gave the impression of serious consideration of the transactions’ investment potential. Kerekes eventually prepared a handout for the group with examples of how to create a record to support an argument that the client had a business purpose for entering into a transaction that had economic substance.³² One template of a memo to the client, for instance, opened with the sentence: “As we have previously discussed, this memorandum addresses some of my preliminary thoughts regarding the investment program you are considering entering.”³³ It also said, “As I understand it, you are planning to pursue a series of investments in various derivative securities, particularly securities that are sensitive to interest rates.”³⁴ The memo went on to say, “The partnership is scheduled to end after 30 years. The partners will have the option of extending it should they choose to do so.”³⁵

In fact, of course, all the partnerships were scheduled to end before the end of the taxable year in which the transaction started. Kerkes’s form memo ultimately concluded, “Over the long term, your potential profits appear essentially unlimited.” Similarly, one letter sent to clients said, “Just a short note to confirm that I thought about the business and tax issues we’ve been discussing and concluded that you should contribute the investment to the partnership.”³⁶ Another said, “For your information, below are some web sites that I came across that may be of interest to you in light of your recent interest in foreign exchange investing,” and listed four websites.³⁷ Still another purported to “[confirm] our recent discussion regarding your plans relative to the hedging, currency, and related derivative investment strategies you are pursuing.”³⁸ Communications like these were sent to various clients notwithstanding that none reflected any discussions that had actually occurred.

Some BDO personnel also suggested that clients take certain steps that would make it more difficult for the IRS to determine that they were engaging in tax shelter activity. Apparently taking their cue from similar advice provided by tax partners at KPMG, BDO’s tax products group advised their clients to report the results of their trading activities through a grantor trust. (KPMG’s use of grantor trusts was described in chapter 5.) This mechanism permitted clients to net their gains and losses from multiple transactions, which hid the large losses at the heart of their shelters from the IRS.³⁹ BDO also advised clients not to deduct their fees for the transactions because the size of those fees might attract attention from the IRS.

In early 1999, BDO revised its fee arrangement with Jenkens so that BDO directly billed the client for fees. The size of the Jenkens & Gilchrist fee had still been a concern because of its potential to undercut any claim that the client was entering into trading activity to pursue a profit. Greisman proposed two alternatives to the tax opinion committee to address the size of the fee. The first option was that the firm continue to execute the short sale transaction but retain the law firm of Ryan & Sudan to issue a tax opinion identical to the Jenkens one, for which that firm would charge $100,000. Greisman was apparently floating the possibility that BDO might part ways with Daugerdas, since he suggested that this first option would involve retaining appropriate legal counsel for the basic corporate work involved in the transaction. Greisman maintained that the size of the legal fee under this alternative would pose no danger of being recharacterized as a transaction cost that would offset any profit potential of the transaction. While he did not discuss it, Greisman also probably had in mind a negative implication of switching to a different law firm. It would incur the wrath of Daugerdas, who might well pursue legal action against BDO for using his shelter without compensating him for it.⁴⁰

The second alternative was the one that BDO eventually chose. BDO restructured the fee arrangement with Jenkens & Gilchrist so that it billed the client directly for its fee and paid the law firm its fee, rather than receiving a portion of the amount paid to the law firm. The fees to the accounting firm and the law firm would ostensibly remain the same, as would the total fee paid by the client. Restructuring the fee reduced the risk that a client’s shelter would be challenged based on economic substance because the client did not have a reasonable prospect of making a profit once the total fees for the transaction were factored in. To accomplish this, BDO would enter into a “consulting” agreement with the taxpayer under which it ostensibly provided financial planning and investment advice. Since the agreement did not refer specifically to the shelter transaction, the hope was that “the IRS would think that the fee was for something else other than the transaction.”⁴¹

Another important advantage of billing the client directly was that BDO did not have to wait until the Jenkens & Gilchrist opinion was provided near the end of the transaction to receive its fee; nor was its fee limited to a percentage of the Jenkens fee. Eventually, BDO charged the client 7 percent of the amount of capital losses and 10 percent of ordinary income losses. It then distributed 2.4 percent of the 7 percent and 3.2 percent of the 10 percent to Jenkens & Gilchrist, which effectively provided the law firm with the same fees that it had been receiving under the prior arrangement.⁴² BDO never told Jenkens, however, that it was now earning a larger fee than Jenkens for simply referring clients to the law firm that had developed the shelter.⁴³

The arrangement proved very lucrative for the accounting firm. As of mid-December 1999, the transactions being executed with Jenkens & Gilchrist were generating fees of almost $18.7 million for BDO. For the last six months of the 1999 calendar year, revenues for BDO were over $185 million, and the projection for the next six months was almost $215 million. If these numbers held for fiscal year 2000, the firm would earn almost $100 million more in revenue than it had in fiscal year 1999. Perhaps more salient for the Tax Solutions Group, the revenues for 2000 would represent more than a $150 million increase—almost 62 percent—over fiscal year 1998, the year before BDO began its initiative with Daugerdas. Even after he became CEO and chair, Field continued to monitor sales and exhort Tax Solutions Group members to push themselves. In a firm-wide email in July 2000, for example, Field celebrated Shanbrom’s success in closing a very substantial deal: “Congratulations to Paul Shanbrom of the Detroit office, who closed a tax solution transaction, resulting in GROSS REVENUES OF $1,900,000 TO THE FIRM!!! TAX $ELL$!!!”⁴⁴

Warning Signs

In 2000, the IRS issued Notice 2000-44, entitled “Tax Avoidance Using Artificially High Basis.” The notice contained some worrisome pronouncements for BDO. First, it described transactions identical to the Short Options Strategy that BDO was promoting with Jenkens and explicitly stated that “[t]he purported losses from these transactions . . . are not allowable as deductions for federal income tax purposes.”⁴⁵ Second, the notice indicated that transactions the same as or substantially similar to BDO’s strategy were “listed transactions.”⁴⁶ This meant they had to be registered with the IRS and promoters had to maintain a list of investors to turn over to the agency upon its request. Finally, the notice directly targeted the practice of grantor trust netting: “In addition to other penalties, any person who willfully conceals the amount of capital gains and losses in this manner, or who willfully counsels or advises such concealment, may be guilty of a criminal offense.”⁴⁷

Notice 2000-44 triggered a profound shock in Adrian Dicker, who apparently had not fathomed the implications of promoting abusive tax shelters and had not appreciated that members of the Tax Solutions Group were recommending reporting techniques that amounted to criminal conduct. “I couldn’t sleep,” he later recalled. “I was crying. I lost concentration. I was tingling. I was just physically and mentally shot.”⁴⁸ Dicker’s ongoing reservations about the short sale shelter had led him to suggest at least twice that BDO end its association with Jenkens & Gilchrist. Most recently, he had expressed his view to Denis Field that another provider had a shelter that could be defended more strongly than the one that Jenkens was providing. Field, however, insisted that the Jenkens transactions were suitable for smaller amounts of loss that could be used by many more BDO clients, which gave the partners more opportunity to find clients, generate revenues for the firm, and earn bonuses.⁴⁹

When Notice 2000-44 came out, Dicker told Field that he wanted to resign not only from the Tax Solutions Group but from the firm altogether. Field suggested that he take a week off to consider. Dicker took Field’s advice and never returned. He resigned from the partnership effective at the end of October. A month later, Field invited Dicker to join the BDO board, which would allow Dicker to continue his health insurance benefits, a concern of great importance to him.

BDO partners tried to take stock of where things stood after the IRS issued Notice 2000-44. Kerekes prepared a memo for the tax opinion committee the day the notice came out discussing its implications at length. He noted that the combination of the notice and Treasury regulations effectively expanded the list maintenance requirement beyond corporations to include individual investors in listed transactions, those lacking economic substance, and other tax-structured transactions.⁵⁰ Before Notice 2000-44, Kerekes contended, while BDO transactions may have been structured for tax avoidance they had been used only by individuals, so BDO had not been subject to the list-keeping requirement. Now Kerekes observed: “It seems clear that our transactions are listed transactions under Notice 2000-44. In addition, it seems very probably that our transactions lack economic substance and/or are tax-structured.”

The question, Kerekes suggested, was to which transactions the new list requirement should apply. His provisional conclusion was that the requirement applied only to clients who signed their engagement letters after August 11, 2000. Kerekes suggested that BDO confirm his analysis with Lawrence Hill, a tax partner at White & Case with whom the group consulted. Hill was not due to be in the office for about ten days, but Kerekes urged the firm to formulate a position immediately: “I don’t think BDO can be without a policy during the coming week.” The group had also begun to investigate how many clients had been advised to engage in grantor trust netting.

BDO decided that it would proceed with the short option shelter in any transaction for which an engagement letter had been received before August 11, which it regarded as the effective date of Notice 2000-44. As Bee noted, the firm “would sign returns and we would go ahead with those tax returns as if the notice hadn’t been issued.”⁵¹ BDO did give clients whose transactions were in progress the option of canceling. The firm lost about $15 million in fees as a result of taxpayers who walked away. The overall effect of Notice 2000-44 was to trigger a wind-down of the Jenkens short option shelter because of both the notice and more general concern that tax shelters were now a high-priority concern of the IRS. BDO nonetheless continued to market shelters covered by Notice 2000-44 for at least another two years by collaborating with other promoters.

Dicker was not the only one who had concerns about BDO’s tax activity. BDO general counsel Scott Univer believed that some features of the Tax Solutions Group’s activities might warrant closer review. The fact that the group charged fees based on a percentage of tax savings instead of hourly rates was unusual for the industry, as were the size of the bonuses paid to partners in the group. In early summer of 2000, Univer ran into a law school classmate at a reunion who was at Skadden, Arps, Slate, Meagher & Flom and discussed the possibility of the firm conducting a review of the Tax Solutions Group. The general counsel was able to convince Denis Field that such a review would be useful. In May 2000, Bee signed an engagement letter with Fred Goldberg, a former IRS Commissioner and Assistant Secretary of the Treasury for Tax Policy and a partner at the firm. Univer apparently asked Skadden to review the substance of some of the BDO transactions. Goldberg responded that the law firm did not issue opinions on transactions designed to minimize taxes and did not want to delve into the ones that BDO was offering. Skadden would confine itself to reviewing and providing advice on the procedures that BDO followed in connection with the transactions on which Tax Solutions Group members worked.

Skadden’s lawyers interviewed people in BDO’s Tax Solutions Group and partners outside the group who worked on tax matters or otherwise were involved in tax transactions and reviewed documents and files that had been created in the provision of services. On September 6, 2000, Skadden provided an oral report to selected BDO partners, with some partners participating by conference call. The gist of the report was that Skadden believed that it had identified problems that “created significant institutional risk for BDO both with respect to its clients and with respect to the government.”⁵² After the meeting, Field cautioned Bee not to make any statements at an upcoming board meeting about the concerns that Skadden had expressed. As a result, Bee told the board that “there was no problem related to the Skadden report.”⁵³

Given the nature of the report’s conclusions, Goldberg decided to put them in writing to avoid confusion or uncertainty. On November 6, Goldberg and Albert Turkus of Skadden faxed a nine-page memo to Univer.⁵⁴ The memo summarized observations and recommendations based on interviews with key individuals and described “a possible course of action the IRS could take if it were to focus upon the Tax Solutions Group’s activity.”⁵⁵ Skadden’s objective in conducting the investigation, the memo indicated, was to gather information about the “processes and procedures” of the Tax Solution Group to see what “could be improved to promote compliance with best practices and minimize the possibility of unfavorable tax consequences to BDO, the Tax Solutions Group, or its clients.”⁵⁶ While the memo made clear that it did not purport to analyze the proper tax treatment of the transactions in question, it noted that “[t]hat substantive issue is, of course, an important threshold question that directly affects the relevance of certain matters covered here.”⁵⁷

The memo described several “consistency issues” that existed because of “significant variations in certain aspects of the interaction between Tax Solutions Group members and clients.” Members of the group did not provide clients with the same material or information, or inform them of the same risks. In addition, there was variation in the extent to which the clients’ outside advisors conducted a separate analysis or had any meaningful discussions with BDO. With respect to “process issues,” the memo stated that the compensation incentive plan “sends powerful signals throughout BDO (facilitated by the ‘Tax $ell$’ broadcast emails and similar announcements) about which activities are valued by the firm.”⁵⁸ The memo noted that the client fees and commissions paid to the Tax Solutions Group members were linked to the size of the tax benefits. As the memo emphasized, the group members were “incentivized to implement the largest possible transactions, without regard to the size of transaction that would best meet a particular client’s needs.”⁵⁹

In addition, the memo questioned whether the IRS would regard the legal opinions for transactions as independent. It suggested that BDO might want to consider alternative arrangements, such as requiring each client to obtain an opinion from “an independent advisor having no pre-existing relationship with BDO or other parties” connected to the transaction. The memo also noted the fact that some members of the tax opinion committee received compensation for every group transaction sold to a client and that management was present on the committee “may create the appearance that it is difficult for committee members to review new transactions with impartiality.”⁶⁰

Finally, a pointed section of the memo headed “Possible IRS Reaction” began with the statement, “Based on the information we learned, the activities of the Tax Solutions Group could be characterized in a very negative light.”⁶¹ A number of practices, the memo suggested, might “be seen as signaling a lack of confidence in the merits of the transactions sold to clients, or as attempts to conceal those transactions from the IRS.”⁶² These practices included: the suggestion by some group members that clients not challenge any adjustments proposed by the IRS and that they invest their tax savings until the applicable statutes of limitations had run; various forms of advice, such as grantor trust netting, on “how to report transactions in a manner that will make detection by the IRS less likely”; the formation of the Tax Solutions Group as a limited liability company, which “could be viewed as evidence that BDO is not confident about the merits of the transactions”⁶³ offered by the group; and the refusal to accept clients who wished to claim a refund for the tax benefit provided by a transaction because this was more likely to trigger IRS scrutiny. The last portion of this section contained an ominous observation:

There are a number of partners in BDO who expressed to us some discomfort with the merits of the transactions presently being offered by the Tax Solutions Group. In some cases, this discomfort extends to pessimism. Members of the Tax Solutions Group have been advised not to spend their compensation bonuses pending the clarification of tax law relating to their transactions. If BDO were to become the subject of a broad IRS inquiry, these sentiments, and perhaps stronger ones, could surface.⁶⁴

The memo concluded that Skadden’s analysis raised “serious issues”⁶⁵ concerning a number of aspects of the Tax Solutions Group’s activities. It recommended in particular that BDO examine the incentives created by the existing compensation system, require that clients obtain legal opinions from their own independent advisors, modify the structure and operations of the tax opinion committee, and eliminate any behavior “that suggests an attempt to conceal the transaction from the IRS.”⁶⁶

Univer passed the Skadden memo along to Field, Bee, and Pamela Packard, director of the National Tax practice. The word came back that BDO wanted to revise the memo, mostly through deletions. Most significantly, Univer was instructed to inform Fred Goldberg that BDO wanted to eliminate the final section on possible IRS reactions. Univer sent a February 16, 2001, message to Goldberg with a revised version of the document that contained this and other changes. The most noteworthy additional revisions were to eliminate the sentence that stated that the substantive merit of the transactions “is, of course, an important threshold question that directly affects the relevance of certain matters covered here,” and a reference to the “‘Tax $ell$’ broadcast emails and similar announcements.”⁶⁷ The final Skadden draft contained BDO’s revisions.⁶⁸ With respect to deleting the final section on the possible IRS reaction, Goldberg said that the firm had not been hired to discuss that issue and that it had been included in the original draft simply to ensure that BDO took the memo’s recommendations seriously.

Ultimately it didn’t matter what was in the Skadden memo because it was never provided to the BDO board or the Tax Solutions Group. Univer was instructed to draft a memo to the board summarizing the memo’s recommendations for the group, but his draft was never circulated. Indeed, in December 2000, before the final version of the memo was done, Bee had told a Tax Solutions Group meeting that Skadden had given BDO “a clean bill of health.”⁶⁹ Similarly, Field told a meeting of BDO managers that Skadden had reviewed the Tax Solutions Group practices and had said they were fine. Univer then clarified to the group that Skadden’s review was limited to the group’s procedures, not the substance of the transactions.⁷⁰ No one beyond a small group of top managers knew that Skadden had serious concerns about how the Tax Solutions Group activities were being conducted.

Univer continued to press for more oversight over the group. He and Field were on the risk management committee, which examined possible sources of liability for BDO. The committee also was charged with deciding whether to take on a client, instead of the partner directly involved making that decision. In an exchange of emails with Univer in May 2001, national tax director Packard argued that the Tax Solutions Group activity should not be reviewed by the committee because it was a separate LLC; what it was doing therefore posed no risk to BDO as a whole. Univer strenuously disagreed. Field was copied on these emails. Eventually he resolved the issue by abolishing the risk management committee.⁷¹

Feeling Some Pressure

On September 26, 2000, shortly after Notice 2000-44 was issued, the IRS Office of Tax Shelter Analysis received an anonymous letter accompanied by several documents. Addressed “To Whom It May Concern,” it said that BDO Seidman “has been offering tax shelters to hundreds of individuals and some corporations through out [sic] the United States.”⁷² When the “‘tax product’” program first started, the letter said, “very little information was made available to BDO’s partners and staff since there was [sic] some concerns about the IRS picking up on what they were doing and putting a stop to it.”⁷³ The letter explained that BDO had decided not to work with corporate taxpayers “since the tax return would require an M-1 item listed on the reconciliation of book income to taxable income and that would be a red flag to the IRS.”⁷⁴ The author went on to say that “it was explained to me that any interest penalty would be offset by the earnings the taxpayer may have benefited from by having the tax dollars not paid to the IRS available to the person to earn on until payment had to be made.”⁷⁵

“BDO and some legal firms have made a tremendous amount of money off of these products,” continued the letter, “at a great expense to the American taxpayer and federal government. . . . These tax products are worse than Al Capone in the amount of tax dollars literally not reported and paid due to the abusive tax shelters being utilized. We are talking about millions of tax dollars lost or deferred.” The letter concluded, “I wish to remain anonymous at this point until I learn about any legal protection that may be available to me since I am sure BDO would pursue my demise. However, I would be willing to be a witness if adequate protection and compensation could be offered me.”⁷⁶ The author said that he would call the IRS hotline periodically and would use a code to identify himself when he did.

The IRS swung into action. On December 5, 2000, it sent a letter to the BDO Chicago office that said, “We believe that your organization was involved in the promotion of transactions substantially similar to those described in Notice 2000-44. . . . Such transactions may be tax shelters [under] the Internal Revenue Code.” If so, the letter said, the transactions should have been registered and BDO would have “an obligation to maintain a list of investors and to make that list available for our inspection.” The letter then requested within ten days “(1) a detailed description of the transaction, including a description of its structure and the intended tax benefits, (2) a copy of any written materials that were presented to potential or actual participants in connection with the offering of sales of interests in the transaction, including any analyses or opinions relating to the intended tax benefits of the transaction, and (3) the list of investors in the transaction.”⁷⁷

Greisman received a call about the letter as he was heading to a previously scheduled meeting of the tax opinion committee at the O’Hare Hilton. Field, Bee, Kerekes, Shanbrom, and BDO partner Larry Cohen were in attendance. When Greisman arrived, he told the group about the letter, which they then read. Field was incensed. He noted that the bottom of the letter indicated that a copy was sent to two persons, one named “Chris Leisner.” Christopher Leisner was a BDO partner in the Chicago office who had been a vocal critic of Field, who now suspected that Leisner might have turned whistleblower. Field instructed Greisman to contact Leisner and tell him to come immediately to the meeting at the hotel. When Leisner arrived, Field grilled him relentlessly. Leisner never admitted that he was the source of the leak.

Tellingly, Univer was never informed by BDO management about the IRS letter. He only learned of it from Larry Hill at White & Case, who was retained by the Tax Solutions Group. Univer then sent an email to Field asking whether he thought that as general counsel of the firm Univer ought to be aware of communications such as the IRS letter. Field’s email response was terse: “No.”⁷⁸

BDO’s response to the IRS letter was to claim that none of its transactions were identical or substantially similar to those covered by Notice 2000-44. The firm refused to register any shelters or to turn over any list of clients to the IRS. “In effect,” Bee later observed, “we hardballed them.”⁷⁹ BDO also decided not to inform any of its clients about the IRS’s inquiry. “It was in BDO’s interest that the clients not be aware of the letter,” Greisman explained.⁸⁰ Otherwise, they “would have been perhaps suing or concerned or asking for fees back.”⁸¹ When some clients began receiving audit notices from the IRS, BDO’s strategy was to be closely involved with the client’s counsel and to keep the process going as long as possible in the hope that ultimately there would be a global settlement on lenient terms.⁸² The firm would “rehearse the client to say, ‘I had an investment motive.’”⁸³ Greisman prepared a spreadsheet that helped the firm keep track of the audits in progress. BDO also decided not to offer the IRS any legal opinions connected with the shelter transactions at the beginning of any audit for fear that these opinions would provide a detailed roadmap of the transactions that would be useful to the IRS. Instead, BDO withheld the opinions on the ground that they were protected by the attorney-client privilege.

BDO played a substantial role in assisting clients in dealing with the IRS audit process. For example, it helped prepare responses to IRS information document requests (IDRs) for its clients Larry and Nancy Moore and their partnership Ellsworth Partners.⁸⁴ The first IDR asked for a description of how the taxpayer became involved in the formation of the partnership, the decision to engage in foreign currency option transactions, and the decision to transfer the partnership interest to LHM Ellsworth Investors, Inc., a subchapter S corporation. The response to the request stated that Mr. Moore had become “familiar with currency issues and ways to make money with currencies” in the course of founding and running a company that had numerous overseas operations and engaged in transactions in different currencies. He and his wife, the response said, “began investing in the stock, currency and bond markets subsequent to the sale of his company in 2000.” They then “decided to purchase foreign currency options to diversify their portfolio, and to earn a profit.” Finally, “[a]t some point, a decision was made to transfer the investing and profit-seeking activity to an S corporation, thus LHM Ellsworth Investors, Inc. was formed.”

The IRS evidently found these responses inadequate and followed up about four months later with another IDR that asked the Moores to discuss “the reasons for engaging in the foreign currency transactions” and “why the partnership interest was transferred to LHM Ellsworth Investors, Inc.” With respect to the first request, the Moores directed the agency to the description in its earlier response. With respect to the second, the Moores provided a more detailed explanation. Because of the substantial risks involved in the partnership’s highly speculative investments in technology stocks and foreign currencies by the partnership, they said, Mr. Moore “determined that it was best to liquidate Ellsworth Partners into LHM Ellsworth Investors, Inc. This transfer also had the effect of giving Mr. Moore increased limited liability protection under state law.” A last IDR about three months later asked the Moores to “[e]xplain how the amount of the fees paid to Jenkens & Gilchrist and BDO Seidman were determined.” In response, the Moores stated, “The fee of $230,400 paid to Jenkens & Gilchrist for the legal opinion was established by Jenkens & Gilchrist. The fee of $514,000 paid to BDO Seidman for various consulting services was established by BDO Seidman.” BDO’s fee, of course, had been simply for referring the Moores to Jenkens.

The IRS inquiry was troubling, but BDO may have felt that it could emerge unscathed if it maintained an aggressive posture toward the government. Denis Field had been the driving force behind a transformation at BDO that moved it beyond traditional audit and tax preparation services. During his tenure as CEO, the firm’s revenues had increased by 60 percent and average partner revenue more than doubled.⁸⁵ Tax services accounted for nearly half of BDO Seidman’s $420 million in U.S. revenues in 2002, up from 28 percent in 1998.⁸⁶ An observer of the accounting industry had once remarked, “Denis Field is such a significant person at [BDO that] he’s the equivalent of Bill Gates at Microsoft.”⁸⁷ Could the same hard-charging approach that had transformed the firm enable it successfully to fend off a sustained government inquiry into how the firm had come so far so fast?

Some of the major accounting firms in the world moved aggressively into the tax shelter business in the 1990s and early 2000s. These firms drew on their audit and attest relationships with clients, marketing networks, and talented tax practitioners to earn substantial profits from this activity. Accountants were not the only professionals involved in the shelter industry, however. Lawyers at respectable law firms lent their services to transactions generating billions of dollars in fraudulent tax losses.